Hong Kong's new crypto funds struggle to clear licensing hurdles

HONG KONG (Reuters) - A year after Hong Kong launched a pioneering scheme allowing fund managers to invest in cryptocurrency assets, barely any players have been approved, highlighting the difficulties the industry faces in its bid to become mainstream.

FILE PHOTO: Bitcoin.com buttons are seen displayed on the floor of the Consensus 2018 blockchain technology conference in New York City, New York, U.S., May 16, 2018. REUTERS/Mike Segar

Market watchdogs globally are debating how and whether they should regulate the cryptocurrency industry and have mostly focussed on protecting investors from the scams based on digital assets.

The licences introduced by Hong Kong’s Securities and Futures Commission (SFC) late last year were among the first of their kind globally and grant fund managers of so-called virtual assets and related intermediaries permission to sell products to investors.

However, a year later, industry players say very few fund managers have been approved to invest in crypto-currencies.

Reuters could only identify one: Hong Kong-based Diginex, which operates a cryptocurrency “fund of funds”. Lawyers and consultants are unable to identify any other applications that have been approved, though dozens of smaller funds looked into applying hoping that approval would help attract investors.

The SFC does not publicly announce information about licence approvals and declined Reuters’ request for comment.

“We believe it is vital to be regulated to build trust with our clients but also in the industry,” said Richard Byworth, CEO of Diginex, which won approval in June.

Larger investors, who might otherwise have been able clear the licensing hurdles, have tended to stay away.

“We have seen lot more interest from smaller funds or crypto-dedicated funds,” said Henri Arslanian, Hong Kong-based global crypto leader at PwC.

Gaven Cheong, a partner at law firm Simmons & Simmons, who advised on their application, said the regulator essentially expected licencees to set up as a full-blown traditional fund manager.

“Last year there was a lot of excitement but since then we haven’t seen much activity,” he said. “Not many new managers in this area have the background, experience or support to mount such an undertaking, and this has meant that many applications never even get started.”

Several market participants said the rigours of the Hong Kong regime had in fact forced some funds to domicile in offshore jurisdictions to skirt SFC requirements for funds based in the city that sell to local investors directly.

Advisers say the industry’s relative infancy is also a factor, with crypto funds still developing systems for custody, audit, cybersecurity and other operational necessities.

“My take is it is more an operational and infrastructure issue, than the regulator being obstructive,” said Rocky Mui, a partner at Clifford Chance in Hong Kong.

Last year’s “crypto winter” also chilled applications. One bitcoin, worth nearly $20,000 in December 2017, fell to below $4,000 by December 2018. It traded around $9,400 on Tuesday.

“The volatility and poor returns in 2018 scared large institutions away from allocating to crypto funds, causing those who survived to shelve their licensing plans,” said Jehan Chu, a partner at Kenetic Capital, which takes equity stakes in blockchain companies.

“As institutional investors step into the market, crypto funds will dust off their licensing applications and take a fully regulated approach,” he said.